Wednesday, March 12, 2014

What causes a bubble? And by bubble I mean a financial one.
One of my favorite books, Manias and Panics (and some other word, I can’t
remember what it was) by Charles Kindleberger, an Economic historian at MIT
said that perhaps when newer technologies come around, there is a tendency to
end overpricing newer assets, as nobody knows what the inherent value is. When the
South Sea company trading at the London Stock Exchange ended up falling from a
massive cliff, it was because the concept of stock trading was somewhat new.
Similarly a bubble occurred when new tech companies came along. Setting aside
new economy BS going around that time, it could be seen that people and media
hyped in a romantic sense what the changing technology could bring about. With
housing I am not really that sure. And in any case Kindleberger didn’t stay
alive to see the bursting of this bubble. So can’t really a deadman what his
opinion was (would be?) about the housing bubble.

The key thing though is that bubbles do end up occurring in
a common occurrence. Just take a look at the current shale boom happening. It
is a bubble. Oil companies involved with it are issuing rosy guidance for the
future, while under stressing the fact that the yield of a horizontal oil well
keeps goes down by 40% - 50%; bottom line? They just have to keep drilling more
and more and more just to breakeven. And guess what? Shale oil is spread out
over miles of land. So it is more of a hit and trial game. Yeah right, the US
is going to achieve the 18.5 millions of barrels in a self-sufficient manner.

I am an economics student in training, but the more I think
about bubbles (it is amongst my favorite areas of topic) the more obvious one
fact becomes- for a bubble to even exist, almost everyone has to believe in the
story itself. I mean, think about it; an economy depends on what all of its
constituents are thinking and believing in the first place. The people who kept
believing the housing market would forever keep going more were the ones who were
pushing the prices upwards. Sure, you had cheap credit available. But you
wouldn’t have taken the credit in the first place if you didn’t want to buy a
house in the first place. And this is why a bubble is similar to a spiral; it
is sustained by people believing the story. Not enough people believed the
house prices would start to collapse in the first place, that’s why you didn’t
have any selling which would have kept the house prices somewhat stable. And I think
that’s the key for a bubble to exist. We all like to believe that the economy
is always impacted by “some other suckers”, but the truth is that you’re part
of it. And collective behavior impacts the economy. The government issues
guidelines but the buying and selling is done by us. And by us I mean you, me,
my roommate. And when something ends up being believed in by pretty much
everyone, of course you’re going to have a “bubble”.

That’s one of the reasons I somewhat find it hard to believe
that the stock market is in a bubble. The mere fact that so many people are
talking about it, somewhat hints that there isn’t one.

But there is one in oil and gas. And I am going shopping
once it bursts. After all I missed my would-be Christmas in 2008.